7/21/2011 @ 3:49PM396 views

No Intent, No Problem: SEC, HHS Pursue Strict Liability For Business Executives

The Washington Post reported this morning that the Securities and Exchange Commission had rejected a recommendation by the agency’s enforcement division to settle a case SEC had filed against former CSK Auto CEO Maynard Jenkins. This confirms that SEC has joined the federal government’s misguided drive to impose strict vicarious liability on business leaders for the unauthorized, unknown actions of others in their companies.

SEC Clawback. Several CSK officers had been engaged in accounting fraud, violations which an internal audit ordered by Jenkins had discovered. SEC’s case against the officials and the company acknowledged that Jenkins was himself a victim of the fraud, as the perpetrators had actively hidden the illegal activity from him. He was never accused of securities fraud or of even being negligent in his management of the company. Nevertheless, the SEC’s enforcers decided to pursue “reimbursement” of Jenkins’ bonuses under the so-called clawback provision of the Sarbanes-Oxley Act (SOX). Section 304 of the Act allows for this in situations where the company was harmed “as a result of misconduct” by the executive whose bonus return is being sought.

In September of 2009, Jenkins had sought a federal court injunction against SEC’s novel use of the clawback provision, arguing that Congress never intended that Section 304 impose strict vicarious liability, and that such an interpretation violated his due process rights. The court denied Jenkins’ motion without addressing the constitutional issues. That forced Jenkins to pursue a settlement and the SEC enforcers, possibly seeking to avoid a constitutional test of clawback theory in court, negotiated a deal. Perhaps motivated by the absurd clarion calls from Congress and the press that financial enforcers are letting executives off the hook too easily, the SEC commissioners rejected settlement, and the case will now go to trial.

HHS’s Moves to Exclude. SEC’s vast expansion of the punitive clawback policy is chillingly analogous to actions taken by the Inspector General (IG) of the Department of Health and Human Services. In 2007, drug company Purdue Frederick pled guilty to criminal misbranding charges. Three Purdue executives pled guilty to one misdemeanor charge under the harsh “responsible corporate officer” (RCO) doctrine, even though they possessed no knowledge of the illegal activities nor participated in it. In an unprecedented move, the IG opted to exclude the three former executives from participation in federal health care programs, meaning they’d never work in the drug industry again. They are challenging the exclusion, with Washington Legal Foundation supporting their appeal with an amicus brief.

In a more recent development, the IG has signalled an intention to exclude the 83-year-old CEO of Forest Labs, Howard Solomon. Forest had pled guilty to criminal charges related to alleged off-label marketing. Solomon was neither charged personally, nor is there any evidence that he was aware of or involved with the illegal activity. To their credit, the Forest board has fiercely signaled its support of Solomon. Business Week has a story on the case here.

Rise of the Status Crime. Punishment and deterrence are two of the main purposes of criminal law, as well as of civil fines. It’s hard to understand how strict, vicarious application of the SOX clawback policy, or exclusion under the RCO doctrine, advances either of these goals. When executives are punished simply because of their positions, rather than any offenses they committed, the concept of punishment is cheapened. Anyone who believes in the basic concept of “the punishment fitting the crime” should be aghast when government puts status ahead of culpable actions.

If executives are punished when no evidence exists to tie them to the illegal actions of their company or of the company’s employees, what is being deterred? And if status is the reason for the punishment, then the only resulting deterrence is the chilling of talented men and women from becoming business leaders. Is that what government wants during an economic downturn?

We look forward to the courts having their say in the case of Maynard Jenkins, and we hope courts have the same opportunity with Mr. Solomon. But such costly, exhausting challenges shouldn’t be necessary, and wouldn’t be if the federal government would put protecting civil liberties ahead of politics and ideology.

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